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Magical public banking

By Emer O Siochrú

Three Irish political parties support publicly-owned banks but the mainstream has yet to be convinced. Ellen Brown who spoke at Kilkenomics in October is on a mission to change that.

Brown claims that a state bank can nearly double its spending power if it puts state money in its own bank as capital and deposits.

I ask what she thought of Deirdre McClusky, Professor of Economics at the University of Illinois, describing that at Kilkenomics as “magical thinking”.

She’s unfazed: “Banking is magical. It’s the source of about 95% of our money supply. Except for paper money and coins, all of our money is created by banks when they make loans. Contrary to popular belief, banks do not lend their deposits. They create deposits when they make loans”. Of course, they need their deposits to clear their cheques.  But where do the deposits come from? Unlike with a revolving fund, which can only lend its money out and then wait for it to come back before lending it again, a bank can generate loans backed by its deposits while the deposits remain in the bank, available to depositors.  The money is effectively double counted.  If the depositor and the borrower come for their money at the same time, the bank can borrow very cheaply from other banks or the money market to cover the shortfall. And that is the magic of banking”.

She is equivocal about the proposed Strategic Banking Corporation of Ireland which is about to launch with €500m in credit for SMEs. “It is not actually a bank. Its money comes largely from KfW, a German publicly-quoted development bank, to help capitalise the Irish banks. The interest on that capital will go back to Germany, and the banks that will be lending the money to small and medium-size businesses are the same three big Irish banks that have not shown themselves to be good stewards in the local lending market”.

In Germany, KfW provides liquidity for a network of skilled, locally responsive 200-year-old publicly-owned banks called Sparkassen. She says “they service about 70% of the domestic SME market and are largely responsible for its viability even in the face of a global credit crisis”.

The Sparkassen group is quite interested in helping Ireland set up a similar network of publicly-owned banks, not because they want to expand into Ireland, which they are not allowed to do, but, according to Brown, because they want to establish the viability of the model, which is under threat in the Eurozone. They describe themselves as the last man standing, fighting for banking in the public interest. She approves.

Another option she moots for Ireland is of a state-owned bank similar to the Bank of North Dakota, the only depository bank in the US that is publicly owned. North Dakota is also the only state that escaped the credit crisis, boasting a substantial surplus every year since 2008. It has the lowest unemployment rate and one of the lowest foreclosure rates in the US. All state revenues are deposited in the Bank of North Dakota by law. The bank then leverages its revenues into credit for the state.

Brown believes that “One of the advantages of public bank ownership is that it can cut the cost to the public of infrastructure in half. On average, 50% of the cost of infrastructure goes to interest. It’s just like with a mortgage”.

Owning the bank also allows the state to direct credit where it needs to go in the community. Publicly owned banks lend counter-cyclically, meaning that when other banks are afraid to lend, the public banks expand their lending.

Public banks also have much lower costs. The Bank of North Dakota doesn’t have to advertise for customers or deposits. It has a captive depositor in the state itself, and it gets its customers by partnering with the local banks, which serve as the front office. The Bank of North Dakota then comes in and backs the loan, helping with capital and liquidity requirements and sharing in the profit. It does not pay bonuses, fees, or commissions, and it has no high-paid executives. As a result, it is highly profitable, for the state.

As to the fact that Ireland already owns over 95% of AIB and 14 to 15% of the Bank of Ireland, she points out that “the public has borne the losses for those banks, but it has not reaped the profits, and until their toxic balance sheets are cleaned up, there won’t be many profits”.  The government has not taken over their direction in the public interest. She considers it would be a smart move for Ireland to set up its own freshly capitalised ‘good’ public bank if only to have a ‘Plan B’ if, or some say when, the current system takes another big hit. •

Emer O’Siochru is a member of the Public Banking Forum, Ireland.